Scott Pfeiffer's Business Blog

Category Archives: Crowdfunding

People who know me know that I like to dig into the numbers. It is all well and good to sit around like a bunch of Renaissance philosophers and talk about solving problems through reason, but I like to see what the actual data has to tell us. With crowdfunding, the data says it is bigger than anyone predicted, getting bigger, and becoming more important every year.

Let’s look at the numbers. In 2012, crowdfunding platforms successfully funded more than one million projects, raising $2.7 Billion for small businesses and entrepreneurs. That is a lot of money, and a lot more money than most would have predicted when Kickstarter launched crowdfunding in the USA just four years ago.

These numbers are with only reward-based crowdfunding permitted in the United States. Equity crowdfunding – allowed by the JOBS Act – is still waiting for SEC Regulations to be approved. Once equity crowdfunding goes live, we will see an additional spike in crowdfunded cash for small businesses and entrepreneurs. [For the difference between these two, read this].

This is important because other sources of cash for entrepreneurs and small business are tightening. For example, while bank lending remains a large source of cash for US entrepreneurs, with $283 Billion in small business lending in 2011, that figure is down from a high of $336 Billion in 2008, and even from $310 Billion in 2010.[1] In fact, small business loans have decreased as a percentage of all non-farm, non-residential bank loans for a decade and a half – from 52% in 1995 to only 29% in 2012.[2]

This lack of access to cash is starving small business, and makes the crowdfunding option attractive.

Of course, a small business doesn’t have to choose between seeking some of the $283 Billion in bank financing or trying to raise some of the predicted $5 Billion in crowdfunding money – a successful crowdfunding raise that not only finances, at least in part, the production of your product, but also proves demand by creating a fan base around the product will help you in getting that bank loan you need to take your business to the next level.

Crowdfunding isn’t here to replace other forms of financing. It’s here to complement them. Whether you are a small business owner who needs funds to complete a dream project or a professional who advises people on raising capital, you increasingly need to consider crowdfunding as a part of your strategy.

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I was discussing Kickstarter and crowdfunding with my friend Richard Bliss (host of the Kickstarter Podcast: Funding the Dream) the other day, and how Kickstarter is changing every industry it touches. My current thought on this is that Kickstarter, where it works, alters the very structure of the economy. It moves us from Capitalism into something different, I think. I called it Post-Capitalism. Let me try to explain what I mean.

First, we need to understand Capitalism. Capitalism is a way of ordering an economy. In Capitalism, the Capitalist is the driver of the economy. Capital is, essentially, money. The Capitalist is the person who aggregates (but doesn’t necessarily supply) Capital. Most often, he aggregates that Capital by raising it from investors by selling them securities of some sort. He then takes that Capital he has raised and puts it at risk in a venture he has selected and will manage. The investors rely on the Capitalists sense of business to make them a return, but understand that their money is at risk and may be lost if the Capitalist performs poorly. The Capitalist owns the means of production, and it is the Capitalist that selects which products or services will be produced for the Customer. The Customer eventually selects the products or services that survive, by buying or not buying (this is the Market Force), but it is the Capitalist that selects the products or services to offer in the first place.

The driving motivator for the Capitalist is profit. He is required to operate his business to create profit and avoid loss for his investors. He does so, traditionally, by making his products or services scalable, replicable, by driving down costs. It was the movement of production out of the shops and homes of the artisans and into the factories that created the Industrial Revolution and Capitalism in the first place. So in Capitalism, the Capitalist, who aggregates the Capital to own and control the means of production decides what products will be created, and he tries to make those products as profitably as possible.

With Kickstarter, we remove the Capitalist from his center position between the creator and the customer. The creator reaches out, directly, to the customers and fans and backers and says “I want to make this, what do you think”. These customers and fans and backers decide what will be made, not after it is made by failing to buy it, but before it is made, by supporting it. The customers and fans and backers provide the capital to create the project, not because they want a return on their investment, but because they are fans – of the artist, of the genre, of the product or service, of art. Because there are no investors to satisfy, and because the customers, fans and backers get on board before the product or service is delivered, risk is reduced. The owner of the means of production is still there, but as a servant of the artist – he will get to make the product after the artist gets funding from his fans.

Certainly in small business, the artist and the capitalist are often the same guy. But unless the small businessman is essentially a free-lancer or independently wealthy, he will likely still need investors at some point, and at that point his capitalist role will overwhelm his artist role.

I am not arguing that Capitalism is dead or un-useful. In fact, equity based crowdfunding is merely an extension of the capitalists aggregation of capital to smaller businesses. It is the democratization of access to capital for capitalists. But Reward Based Crowdfunding is different. It is new. Or perhaps it is old, and new again. And it is changing things in interesting and unexpected ways.

To close, let me give an example of what I am talking about. I love history books. But I have noticed, and so have other people I talk to, that history books have fewer and fewer really nice color maps in them. A friend told me that this is because map making is expensive. The traditional publishing model (where the historian is the artist, the publisher is the Capitalist, and I am the customer) simply does not have a place in their paradigm to pay a mapmaker to make a bunch of maps. The artist can’t pay for it out of his cut – he is making little as it is – and the Capitalist won’t pay for it because the cost will not make a large enough return on his investment to warrant the risk. Customers will buy the book without all the maps, and the Capitalist will have lower costs and higher profit. So, we get as few maps as possible.

But historian Dana Lombardy has a different idea. He wants to write a book about the campaigns of U.S. Grant, and he wants to make his book full of maps. Colored maps. Detailed maps that really tell the whole story of each battle he describes. He bets there are fans out there that want this book to happen, even if there are not Capitalists out there who see enough return on investment to risk their capital on it. So, he is going to Kickstart it.

If he’s right, customers and fans and backers will back his project and give him the money he needs to print the book full of maps. And in return, they will get a thank you, or a signed copy of the book, or a framed map, or some other reward that Lombardy decides to offer as a thank you for their support. If he’s right, and the customers want this product to exist, it will exist.

That’s Kickstarter. That’s reward-based crowdfunding. My friend Richard Bliss and I are going to help Dana Lombardy with his project – it will be interesting to see it progress.

Have any thoughts about Kickstarter or Capitalism? Leave a comment and let’s have a discussion.

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There’s a new buzzword flying around entrepreneurial circles these days – Crowdfunding. It’s cool, it’s new, it’s sleek, but what is it? Discussions of it are confusing:

“It’s a growing phenomenon that’s changing the world”

“It’s illegal“

“It is happening now and it’s huge”

“You can’t do it yet”

What is going on? Who can you believe? I will try to bring some clarity to the contradictory mess of information out there, because – it’s all correct.

How can the statements above ALL be correct? Simply this: The new buzzword “Crowdfunding” is being used to describe two similar butdifferent things.

Crowdfunding is essentially allowing large crowds of people fund projects or businesses with a small amount of money from each of them, rather than traditional small business funding, where a few people put in larger amounts of money.

Crowdfunding has been around for a long time. The New York Stock Exchange is, essentially, Crowdfunding for large corporations. Lots of people pay a little each to own equity in a large corporation. Nonprofits have also always been Crowdfnded – the Preacher wants to deliver a product (the sermon and counseling, maybe some religious education), he passes the basket every Sunday and asks his backers (the congregants) to Crowdfund the Church by donating money to support the project.

So Crowdfunding is a familiar activity – so why the Buzz? The Buzz is over new ideas and new laws that will allow small businesses, entrepreneurs, inventors, artists, etc. to use this powerful tool, where before it could only be used by large for-profit corporations and non-profits.

The confusion comes from the two different Crowdfunding models that are being talked about today – I call them Reward Crowdfunding and Equity Crowdfunding.

Reward Crowdfunding is already happening, and is a growing phenomenon that, in the words of Richard Bliss, founder of the Crowdfunding Academy, “Is changing every industry it touches”. In Reward Crowdfunding, a person or small business funds a discrete project with a concrete deliverable by seeking backers on the internet. The backers fund the project primarily because they are fans – fans of the project owner, fans of the artist, or even just fans of the genre. In return for funding, the project owner offers the backers some tangible rewards. These rewards are less valuable than the money pledged: the idea is not to sell the rewards it is to raise funds to complete the project. Rewards can be as simple as a thank you, or a telephone call from the project owner, or a signed copy of the final product. The backers get only their reward, and never get any of their money back or any share of profits. They have backed the project simply because they want to be a part of its success. The project manager’s only responsibility is to deliver the rewards he promised – the money pledged is his to keep.

Reward Crowdfunding – because it does not involve the sale of “securities”, is legal and has been legal forever. It is the internet that has allowed it to succeed – permitting project owners to reach out and find backers in a way that would have been impossible before. And it is thriving. The largest site for Reward Crowdfunding is Kickstarter (www.kickstarter.com). According to Kickstarter “Since our launch on April 28, 2009, over $450 million has been pledged by more than 3 million people, funding more than 35,000 creative projects. “ That is amazing. Kickstarter’s biggest competitor is Indie Go-Go (www.indiegogo.com). It offers a slightly different take on Reward Crowdfunding. Together, they will soon pass the $1 Billion in pledged funds mark.

Equity Crowdfunding is a bit different. Rather than allowing you to fund discrete projects with the backing of your fans, Equity Crowdfunding allows an entrepreneur to raise capital for his business by selling shares in his company – securities – in the same way large companies raise capital by selling shares on a stock exchange. The difference is one of regulation. To sell shares on a stock exchange, a company must register their offering with the United States Securities and Exchange Commission as a public offering. This is an expensive process that effectively forecloses this way of raising capital to any but the largest corporations. There have always been exemptions from the registration requirements, but they have either not permitted advertising (especially on the internet) or restrict the types of investors who can invest to residents of a certain State or to wealthy investors.

Equity Crowdfunding will remove those restrictions, and allow small business to raise capital from anyone using the internet without going through the expensive registration process. The business will be required to use an approved “Crowdfunding Portal” and make certain disclosures, but after that anyone can purchase that company’s shares and become a part of the business. Investors will receive equity in the company, and a right to share in that company’s future profits. They will be able to sell their shares later, similarly to someone who buys shares of Coca-cola or Microsoft on a stock exchange.

Equity Crowdfunding is, and has been, illegal. You cannot do it, yet. In 2012, Congress passed and the President signed the JOBS Act, which will permit Equity Crowdfunding in the United States. The Act puts limits on the total amount a company can raise using Equity Crowdfunding, and on the amount any given investor can invest using Equity Crowdfunding – but it will be legal. Before it can become legal, however, the SEC must issue regulations giving the details of how it is to be implemented. Those regulations are expected this year – so Equity Crowdfunding is coming, ut it isn’t here yet.

Will Equity Crowdfunding succeed as wildly as Reward Crowdfunding has? Who will use it and for what? What will company owners have to offer Equity backers to get them to invest? All these questions remain to be answered – what do you think? Let us know.